Multivariate modelling of 10-day-ahead VaR and dynamic correlation for worldwide real estate and stock indices

Abstract

Purpose

The Basel Committee regulations require the estimation of value-at-risk (VaR) at 99 percent confidence level for a ten-trading-day-ahead forecasting horizon. The paper provides a multivariate modelling framework for multi-period VaR estimates for leptokurtic and asymmetrically distributed real estate portfolio returns. The purpose of the paper is to estimate accurate ten-day-ahead 99%VaR forecasts for real estate markets along with stock markets for seven countries across the world (the USA, the UK, Germany, Japan, Australia, Hong Kong and Singapore) following the Basel Committee requirements for financial regulation.

Design/methodology/approach

A 14-dimensional multivariate Diag-VECH model for seven equity indices and their relative real estate indices is estimated. The authors evaluate the VaR forecasts over a period of two weeks in calendar time, or ten-trading-days, and at 99 percent confidence level based on the Basle Committee on Banking Supervision requirements.

Findings

The Basel regulations require ten-day-ahead 99%VaR forecasts. This is the first study that provides successful evidence for ten-day-ahead 99%VaR estimations for real estate markets. Additionally, the authors provide evidence that there is a statistically significant relationship between the magnitude of the ten-day-ahead 99%VaR and the level of dynamic correlation for real estate and stock market indices; a valuable recommendation for risk managers who forecast risk across markets.

Practical implications

Risk managers, investors and financial institutions require dynamic multi-period VaR forecasts that will take into account properties of financial time series. Such accurate dynamic forecasts lead to successful decisions for controlling market risks.

Originality/value

This paper is the first approach which models simultaneously the volatility and VaR estimates for real estate and stock markets from the USA, Europe and Asia-Pacific over a period of more than 20 years. Additionally, the local correlation between stock and real estate indices has statistically significant explanatory power in estimating the ten-day-ahead 99%VaR.

Citation

Degiannakis, S. and Kiohos, A. (2014), "Multivariate modelling of 10-day-ahead VaR and dynamic correlation for worldwide real estate and stock indices", Journal of Economic Studies, Vol. 41 No. 2, pp. 216-232. https://doi.org/10.1108/JES-06-2012-0082